Sydney

'Structural Vacancy’ starting to emerge in CBD office markets

2013-09-18T05:00:00Z

With almost 40% of office buildings in Australia in excess of 30 years old, ‘structural vacancy’ is starting to emerge in those buildings without refurbishments, where there is functionally obsolete space that remains vacant for long periods

AUSTRALIA, 18 SEPTEMBER 2013 – Historically, office vacancy rate forecasts have focused on the opportunities and risks to the demand-side of the equation. However, a new research paper by Jones Lang LaSalle argues that in a low demand environment that Australian office markets are currently in, the supply-side of the equation becomes the key variable in determining the vacancy rate outlook.

Australian Head of Office Leasing, Tim O’Connor said Jones Lang LaSalle is projecting that completions across CBD office markets will be nearly 30% less over the next 10 years, resulting in the equilibrium vacancy rate rising by at least one percentage point to sit at between 8-10%.

“There is a misconception that completions equal supply. On this scenario of a 1% increase in the equilibrium vacancy over the next 10 years, there are a number of supply side factors at work.

“Firstly, over the next 18 months there is only a moderate development outlook. The development pipeline across CBD office markets is 384,400 square metres – that’s only 2.3% of total stock and almost two-thirds of this is pre-committed.

“Secondly, what will happen to Australia’s ageing office stock over this 10 year period? Almost 40% of Australia’s office stock is in excess of 30 years old and Sydney has the oldest office stock in Australia.

“That means this office stock design and functionality is of the 1980’s or earlier. While a proportion of office product has, or can be, refurbished to meet the requirements of future office space users, a degree of what we have termed ‘structural vacancy’ is starting to emerge in CBD office markets. This applies to those buildings without refurbishments where there is functionally obsolete space that remains vacant for long periods, which will result in withdrawals for major refurbishment.

“The long-term impact of structural vacancy will be an increase in the equilibrium vacancy rate. Historically, equilibrium vacancy was assumed to be between 7% and 9%. Conceptually, when vacancy falls below 7%, rental growth accelerates and a new construction cycle emerges. Above 9%, rental growth stalls, shutting off construction activity until vacancy tightens.

“There is currently a symbiotic relationship between tenant, developer and investor. Large occupiers are looking for the next generation of office accommodation to consolidate multiple tenancies, achieve efficiency gains and contribute to the physical infrastructure to make productivity improvements. Developers are actively courting these pre-commitment tenants to under-write future earnings, while investor demand is strong for long dated lease product,” said Mr O’Connor.

The Jones Lang LaSalle research paper, titled ‘Analysing the Supply Side of the Equation across CBD Office Markets’, assesses the potential impact of stock withdrawals on CBD office markets, particularly in terms of age of current stock and competition from alternate uses.

Director of Capital Market Research, Andrew Ballantyne said, “The ageing of Australia’s office stock and the potential for residential conversions make it essential for scenario analysis of the vacancy outlook to incorporate withdrawals and the impact of this on supply.

“Strong growth in CBD resident populations is generating demand for sites and exerting upward pressure on land values. Jones Lang LaSalle projects 49,400 units will have to be constructed to accommodate the growth in CBD resident numbers to 2031.

“For assets experiencing a level of structural vacancy, the highest and best use will become a conversion to residential.

“Completions and supply are used interchangeable in commercial property, however completions and supply are inter-related but have different variables and respond to different economic drivers.

“The underlying demand for commercial real estate is projected to be lower over the next decade. Deloitte Access Economics projects base office demand across CBD office markets will increase by an average of 1.9% per annum between 2012 and 2022. To put this figure in context, base office demand increased by 2.5% per annum between 2002 and 2012, a period which covered the reduction in white collar employment over the financial crisis.

“The next decade will see considerably less development activity than the 10 years to 2012, with the next wave of development activity being pre-commitment led,” said Mr Ballantyne.